A Little Business Structure Goes a Long Way

Is a LLC (limited liability company) the right choice, or is it better to open a corporation? Is it best to simply operate as a sole proprietorship?

On our national call-in radio program, we hear variations of this question a lot. The answer lies in the specifics associated with your business.

To help you determine the best business structure, we’ve put together an overview of several options. For starters, it’s important to take the time to review your personal and business objectives by developing a business plan. What should emerge are answers to questions like,

  • Do you want investors as shareholders in your company?
  • Do you want to maintain control of the business if you have investors involved?
  • Do you anticipate losses in the early stages that can be taken as tax benefits by shareholders?
  • Do you want to avoid double taxation?
  • Is there a great risk of liability associated with your specific startup business?
Article is continued below

Think through these questions carefully since your answer to each will help guide you to the right business structure and steer you away from the wrong one.

To help you determine the best structure for your small business, we’ve put together an overview of several options. And remember, it’s always best to work closely with an attorney and/or accountant to ensure you make the right choice.

Sole Proprietorship

Let’s say you are a graphic designer and plan to offer your services on your own without involving any partners. You might consider forming a sole proprietorship. To start, all you need to do is begin selling your product or service, keep separate business records and a separate checking account, pay self-employment taxes on a regular basis, and report all income on your individual tax return. To keep track and make things simple, it’s a good idea to establish a separate bank account and credit card(s) for your small business.

As with many things in life though, there is a catch. In a sole proprietorship, all personal and business liabilities are combined, and the business is not considered to be a separate entity. That means if an unsatisfied customer decides to sue you, he or she can go after both your personal and business assets and could end up tanning on the Waikiki beaches courtesy of your life savings!

In fact, Jeffrey Weiss, Esq., of Jaffe, Raitt, Heuer & Weiss, P.C. – an experienced, no-nonsense lawyer we’ve grown to trust over the years – has some wisdom to share about the unnecessary risks you assume with this structure: “There’s no reason to incur the potential liability of a sole proprietorship because now it’s so simple and relatively cheap to form an entity,” he states.

Upside

  • Easy to start
  • Low cost
  • No double taxation

Downside

  • High risk/liability
  • All responsibilities on single owner
  • Only one owner allowed

Partnerships

Maybe you and your friend want to start a business. If that’s the case, then a sole proprietorship is out of the question. Instead, you can form a partnership where you are both considered business owners who contribute time, money, skills and other things in order to share business profits, assets and losses. In a general partnership (also called co-partnerships in some states), the partnership can buy and sell property, products and services as a separate legal entity, but both you and your partner must report the income from the partnership on your individual tax returns.

With this business organizational structure, you’ve also got to know your partner really well. Answer questions like: How much do I trust my partner? How aligned are my partner’s goals with mine? Do my partner and I have a track record of weathering difficult situations together?

But even if your answers are encouraging, liability remains an issue with this structure. “For similar reasons to the sole proprietorship, a general partnership is not a preferred choice of business entity either,” states Weiss. “The partners are completely liable for all the obligations of the partnership so there’s no limitation of liability, and there’s too much exposure.”

Of course, you could always form a limited partnership where the partners only risk what is stated in their contract when they first start the business. Just remember that in all partnerships, it’s essential to indicate all the ownership specifics and the various management and liability responsibilities in an official agreement before moving forward.

Upside

  • Easy to start
  • Low cost
  • No double taxation

Downside

  • High risk/liability
  • Each partner responsible for liabilities
  • More costly than sole proprietorship

Corporations

If you’re ready for the big time and want to sell shares of stock in your business, consider a C Corporation. All publicly-traded companies are C Corporations which are considered a separate legal entity from the owners (also called the shareholders or stockholders) of the business. Because of this, the shareholders are not responsible for fees, liabilities and losses associated with a company organized under this business structure.

Incorporate safely online with StartupNation

The stock money and assets earned by the corporation belong to the corporation. Dividends are distributed to shareholders under the direction of the corporation’s shareholder-elected Board of Directors. Stockholders then pay taxes on the earned dividends, and the corporation also pays taxes on all profits (known as “double taxation”).

To become incorporated, you fill out the appropriate documents for the state and have all shareholders vote on overall corporate management, stock shares, the name of the company, business industry and other key guidelines.

Note that you will need to hold annual stockholder meetings and keep meticulous records to avoid legal and accounting problems. In addition, forming a corporation is an intricate process, so we highly recommend that you find a good attorney or consultant to assist you.

Upside

  • Simple to start and inexpensive
  • Low risk/liability
  • Can sell stock shares
  • Easy to add owners and investors

Downside

  • Less flexible
  • Double taxation
  • Strict guidelines

S Corporations

It is possible to avoid the double taxation of a C Corporation by forming an S Corporation. Here, the corporation’s income is divided among all of the shareholders who report the earnings on their individual tax returns. This is a tax-efficient way to structure your business if you expect losses in the short term because the individual shareholders can report the losses on their tax returns rather than paying the double taxation of the C Corporation.

The downside is that to become an S Corporation, you must run the company according to a fiscal calendar year, have less than 35 individual stockholders who are all U.S. residents, and have only one class of stock, in addition to other guidelines.

Upside

  • Easy to add owners and investors
  • Low risk/liability
  • No double taxation

Downside

  • 100 shareholder limit
  • Shareholders must be U.S. residents or resident aliens
  • Strict guidelines

Limited Liability Company or LLCs (Our Favorite)

More than likely, you’ll probably end up with the most popular (and most recently introduced) small business structure – a Limited Liability Company (LLC), which, in essence, combines qualities of a corporation with a limited partnership. Like a corporation, an LLC is a separate legal entity so the owners are not responsible for the debts and liabilities of the company. However, no stocks are issued.

Form your LLC online with StartupNation

Let’s say you want to have your sister, significant other, best friend and father manage your LLC. If you think it makes sense and will work, go for it! There are no rules as to who can be LLC members or managers. Best of all the owners can avoid double taxation with this “pass-through” entity. They only pay taxes on their distribution of the LLC’s profits through their individual tax returns.

Now, if you’re planning to sell stock in your company or go public, an LLC might not be the right choice. Also note that since the LLC is the newest type of entity, some states and countries still do not recognize it as a legal business structure.

Upside

  • Low risk/liability
  • Unlimited flexibility
  • No double taxation

Downside

  • No stocks issued
  • Difficult to go public
  • Reporting guidelines
  • Not recognized in all states

Our Bottom Line:

If you’re anything like us, you’re probably romanced by the exciting possibilities of your business concept, making it even more important at those emotion-charged early stages to be methodical about the mechanical aspects of your business. One of those, without a doubt, is choosing the right business organizational structure. Therefore, before you get too far down the road pursuing your business dreams, remember our advice: A little business structure goes a long way.

  ABOUT THE AUTHOR:
StartupNation Writer
StartupNation Writer

Inside our site, you’ll find all the easy-to-follow, practical information you could ever need to start and grow your own successful business.

Lineage2, Aion, Blade And Soul

StartupNation Free Launch Assessment! Get Started Now